Retiring on a Low Income
After years of working at minimum wage retail jobs without benefits, Donald, age 59, is wondering what his strategy should be for retirement. He knows that he can begin taking the Canada Pension Plan (CPP) as early as next year, when he turns 60, but he doesn’t know whether that is the best choice to make. People have told him that he should wait until 70 because the longer he waits to take CPP the more he will get. But he doesn’t think he can keep on working to 70. It’s already getting hard to be on his feet all day at his job.
Donald started working straight out of high school in the small town he had been raised in. For the first decade or so, he had been living with his parents. He paid them a portion of his income for room and board every month, which he was glad to do. To his surprise, on his 30th birthday, his parents told him that they had saved the money he had given them over the years and said that money was now going to be used to make a down payment on a 1-bedroom condo in town. The mortgage payment, property taxes, and other fees were about the same as what he had been paying to his parents so Donald found that he could afford it. When he had asked his mom and dad why they had done this, they said that they had helped his older brother and sister to get their starts on living independently and it was now his turn.
When Donald started working, his parents had also told him he should start saving for his retirement. For an 18-year-old that seemed like a long way in the future, but he depended on his parents for guidance, so he did as he was told and started putting $50 per month into an RRSP mutual funds account which he had opened at the credit union where he had his chequing account.
Ten years ago, Donald’s mother died. Last year, his father died, too. He and his siblings were each left with an inheritance of about $120,000. Donald decided to pay off the $40,000 remaining on his mortgage, spent another $18,000 to buy a newer car, replacing the car he had owned for the last 15 years, and paid $2,000 for a new computer, printer and internet-related hardware. He left the remaining $60,000 in his chequing account because he didn’t know what to do with it. He thought maybe he should put as much as he could into his RRSP, but he wasn’t sure. Fortunately, the next time Donald went to his credit union, he was told that a financial planner who specialized in retirement planning for low-income earners was going to hold a webinar, to which he was invited.
Low-Income Retirement Planning
When he logged into the webinar on his new computer, he learned about:
The Registered Retirement Savings Plan (RRSP)
The RRSP is a government-approved plan to save for retirement that helps to lower taxable income when people contribute. For the person who has a lower income, this is usually not the best way to save for retirement because low-income earners usually do not pay very much income tax anyway.
The Registered Retirement Income Fund (RRIF)
When someone with an RRSP turns 71, they are required to turn their RRSP into a RRIF, an annuity, or cash it out. The RRIF is the most popular option. Each year after, the RRIF owner must withdraw a minimum amount from their account. Money withdrawn from a RRIF is taxable.
The Tax-Free Savings Account (TFSA)
This is an account that can be set up at a bank, credit union or many other financial institutions. In 2021, contributors can put in $6,000. Anyone who has been eligible to contribute to a TFSA since it first became available in 2009 but who has never done so, can contribute a maximum of $75,500 as of 2021. Income from the TFSA does not count as income for tax purposes or when you apply for any income-tested government assistance programs like the Guaranteed Income Supplement (GIS). The TFSA is usually the better way for low-income earners to save compared to the RRSP.
The Canada Pension Plan (CPP)
Employed individuals who earn above the minimum threshold of $3,500 must contribute to the CPP. The normal age for retirement in Canada is age 65, but a person can choose to begin receiving CPP payments from as early as age 60 to as late as age 70. The earlier CPP is taken, the lower the monthly amount received.
Old Age Security (OAS)
Unlike CPP, OAS is not based on contributions from income but on residency. Also, unlike CPP, OAS is not available before age 65. Anybody who meets the full residency requirements can receive $618.45 per month as of April 2021.
The Guaranteed Income Supplement (GIS)
People who have little or no income beyond OAS at age 65 can receive the GIS. To be eligible for the GIS, a person must be receiving OAS. How much GIS is received depends on taxable income from sources other than OAS. In other words, the person who has more income will receive less GIS.
Canada’s Three-Legged “Stool” for Retirement Income
OAS is a guaranteed source of income for retired seniors age 65 or older who meet the residency requirements. If other sources of income are low enough, then GIS kicks in.
CPP is not guaranteed because it requires recipients to have contributed to the CPP during their working lives from their sources of income. Someone who was never employed, or who never earned enough to contribute, will not receive CPP.
Private Pensions and Personal Savings
Seniors who were part of one or more pension plans through their work, and/or saved for their retirement while working, can draw on these sources for additional retirement income.
After the Webinar Donald Has Questions
When Donald heard that the RRSP may not have been the best way to save for retirement, he began to wonder what he should do. Fortunately, the credit union that had sponsored the presentation offered participants an opportunity to sign up for a review of their financial circumstances and a recommendation about steps they should take. Donald signed up and was told to bring copies of his Notices of Assessment, his statement of CPP contributions, and his CPP income estimates.
Reviewing Donald’s Financial Situation
Donald had contributed to CPP throughout his working life, but he didn’t have a lot to show for it. His estimated monthly CPP if he was age 60 today was $350 per month, at 65 $547 per month, and at 70 $777 per month.
Since Donald had lived in Canada all his life, he was eligible for the full $618.45 per month – if he was 65 years old today. He was told that this figure would be adjusted for inflation each quarter so it would be more in 6 years when he actually was 65 but it would have about the same benefit then as $618.45 per month now.
As a single man, Donald learned that the maximum he could receive if he was 65 today was $923.71 per month, but that it would decrease depending on his income.
Thanks to his steady contributions, which he had increased with each hike in the minimum wage, Donald’s RRSP has grown to $75,000. Given what he had learned at the webinar, though, Donald was wondering whether it made sense to keep on contributing to his RRSP.
Donald had never even heard of the TFSA before the webinar but now he realized that maybe he should have been contributing to this account rather than his RRSP since 2009.
Like most minimum wage earners, Donald’s employer did not offer a pension plan.
Donald earned $29,200 in 2020 and $27,700 in 2019, in keeping with a full-time minimum wage earner in his province. Estimated income for 2021 going forward will be $30,000.
After reviewing Donald’s information, the financial planner provided Donald with two scenarios. In the first scenario, Donald carried on with his current practice. He contributed about 9% of his annual earned income into his RRSP. He delayed taking CPP until reaching age 65, at which time he retired. He did not open a TFSA. As for the $60,000 left over from his inheritance, he added that to his regular RRSP contributions, contributing $12,000 per year over the next five years. From age 65 to 71, Donald was eligible for $6,669 in GIS annually. Thereafter, from age 72 to his death, he would only receive GIS of $668 per year because he began withdrawals from his RRIF. The result: from age 60 to his projected death at 95, Donald’s cumulative income would be approximately $906,530.
In the second scenario the financial planner had Donald taking CPP at 60 and ceasing contributions to his RRSP in favour of opening and contributing to a TFSA. The $60,000 went into the TFSA as well as any contributions he would have previously made to his RRSP. In this scenario, too, Donald retired at 65. However, because he started taking CPP earlier and diverted his contributions from his RRSP to his TFSA, he was able to keep a larger portion of the GIS. Even though his overall income from age 72 on was lower by $299 each year, the up-front income benefit from ages 60 to 71 more than compensated. In fact, Donald’s overall benefit from taking CPP earlier and shifting contributions from his RRSP to his TFSA was over $34,000. The answer was clear. Donald should choose the second scenario. See the table below for the details.
John Stapleton: The Source for Low-Income Retirement Planning
John Stapleton is almost certainly the leading expert in Canada on low-income retirement planning. A former Ontario public servant, he worked in the area of social assistance policy for 28 years. Please go to his website Open Policy Ontario for more information on this topic. The ideas for this blog post drew in particular from a PDF available on his website which you can find here. If you expect to have a low income going into retirement, or you know someone for whom a low-income retirement is likely, this is an excellent resource.
Finally, note that “Donald” and his financial circumstances are fictitious.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.